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By Ahmed Ishtiaq

Altria Group (NYSE:MO) owns the largest cigarette company in the U.S. Altria operates through subsidiary Philip Morris USA, which sells Marlboro -- the world's number 1-selling cigarette brand. The company controls about half of the U.S. tobacco market. It manufactures cigarettes under the Parliament, Virginia Slims, and Basic brands, among many. Altria, however, is diversifying from solely a cigarette maker to a purveyor of cigars and pipe tobacco, through John Middleton Co., smokeless tobacco products, through UST, and wine, through UST subsidiary Ste. Michelle Wine Estates. Another subsidiary, Philip Morris Capital Corp. holds a group of finance leases. Altria also owns a 27% stake in SABMiller.

Dividend Profile

Altria group is one of the best dividend-paying stocks in the market. The company pays an annual dividend of $1.76 per share, yielding 5.10%. At the moment, the stock is one of the few stocks yielding over 5%. I always look at free cash flows while evaluating the dividend stability of a company. Altria free cash flows have been adequate till 2011. However, over the past three years, free cash flows for the company have decreased. Trailing twelve months free cash flows for Altria are below the amount of cash dividends.

The company paid $3.35 billion in dividends and generated $3.06 billion in free cash flows. The biggest reason for a fall in free cash flows was a decline of almost $500 million in operating cash flows. However, looking at the past five years, it is apparent that the company has maintained a high payout ratio. In 2010. Altria paid more in cash dividends than the company generated in free cash flows. The payout ratio for 2010 was 113%. Let's go through the free cash flows and see the trend in free cash flows and some important metrics over the past three years.

Free Cash Flows

Free Cash Flows

2012

2011

2010

2009

Net Income

$3,915

$3,393

$3,907

$3,208

Depreciation and other noncash charges

$238

$253

$276

$291

Funds from Operations (FFO)

$4,153

$3,646

$4,183

$3,499

change in noncash current assets

$528

$18

$1,038

$25

change in noncash current liabilities

$456

$15

$378

$31

Operating Cash flows

$3,169

$3,613

$2,767

$3,443

Capital Expenditures

$107

$105

$168

$273

Free Operating Cash Flow

$3,062

$3,508

$2,599

$3,170

Source: SEC Filings

Over the past four years, the company has experienced some volatility in its net income. Especially in 2010 the net income went up substantially. The same pattern is evident in funds from operations of the company. However, cash flows from operations were at the lowest level in 2010 over the evaluation period. Capital expenditure is not a substantial expense for the company, and over the past four years, capital expenditure has remained below $300 million. At the end of 2009, the firm spent $273 million in capital expenditures; however, by the end of 2011 the capital expenditures for Altria had come down to $105 million.

The company generates healthy free cash flows. In my previous free cash flow analysis articles, I only considered data up to 2011. However, for this article, I will be taking into account trailing twelve month data of the company. In the past twelve months, the company reported $3.9 billion in net income. Funds from operations have improved over the last year. Furthermore, capital expenditures have remained fairly stable, and free cash flows have come down by almost $500 million compared with the last year.

Essential Metrics

Essential Ratios

2012

2011

2010

2009

Funds from Operations(FFO)/Total Debt

0.32

0.28

0.34

0.31

FFO/Capital spending requirements

38.81

34.72

24.90

12.82

Free Operating Cash Flow + interest expense/ Interest expense

3.51

3.88

3.29

3.67

Debt Service coverage

2.35

3.96

2.98

3.50

For my analysis, I have used four ratios. First ratio indicates that the debt of the company is adequately covered with the FFO. The ratio has shown a mixed trend over the past four years. Nevertheless, the firm is generating enough cash flow to cover the long-term debt. The second metric indicates that capital expenditures of the firm are easily covered with the FFO of the company. Since capital expenditures are not a big expense for the company; it should not have any trouble meeting its capital requirement.

The last two metrics in the table indicate that the firm is able to meet its interest and debt payments sufficiently. Interest coverage is extremely strong for the company, and it should not face any trouble paying its interest obligations. Furthermore, debt service coverage is also covered with cash flows. Debt service coverage for the past twelve months has come down due to an increase in the short-term debt. Overall, the solvency position of the company is solid.

Summary

Dividend stocks have a special pull for some investors, and Altria is one of the most attractive stocks in the market. The company has some of the best brands available in the market. Furthermore, the company is also diversifying its asset base. My analysis of free cash flows shows that the company pays almost all of free cash flows in dividends. In addition, debt and coverage metrics are incredibly strong for Altria. I believe the strength of the portfolio of its products allows the company to pay such high dividends. I expect Altria to maintain its high payout ratio and reward its investors with substantial income.

Source: Altria Group: Juicy Dividends Set To Continue